Weekly Update: Did you flood?

09-29-2017

This is a question I heard over and over in a marathon two days of meetings this week in Houston. Harvey was described to me as three days of hard, uninterrupted rain, the largest-ever rainstorm in U.S. history, moving at just 1-2 miles per hour. Over 17 trillion gallons of water fell—to put that into perspective for northerners, it would represent 51 feet of steady snowfall. Every single street was flooded, and whether your home was a victim or not was a matter of whether your door was just 18 inches higher than your unlucky neighbor’s. Over 150,000 homes flooded and over 500,000 cars/trucks were destroyed. With the nasty “pleasantries” discussed, advisors’ moods were quite bullish (melt-up watch) about the market. This week’s unveiling of a tax-reform blueprint is an unabashedly positive story for the market, which views lower corporate rates—especially for small-cap companies—as a huge plus. It understands whatever happens is likely to be a 2018 event. It’s just happy to see movement. While the devil will be in the details hashed out between the White House and Congress—a process that already has begun and may not be so bullish until it’s done—the 9-page guideline provides lawmakers with enough detail to go forward with a 2018 budget, which must come first and could get messy. Details are likely to become known in coming days, with a committee vote possible next week. If the House and Senate are able to pass a resolution that makes room for a tax cut of $1.5 trillion—in the range of various estimates of the tax-cut revenue impact over 10 years—it would substantially raise the odds of enactment of tax reform next year. By contrast, a revenue-neutral tax instruction in the final budget resolution would make reform exceedingly difficult, as would failure to agree on a budget resolution at all.

When the sun came out and the waters receded, the ramifications of Harvey were breathtaking. Homeowners began removing sheetrock, furniture (I saw a block lined with sofas) and all manner of debris, piling up along every street, in neighborhood after neighborhood of this sprawling, flat (“as a table”) fourth most-populous city in America. It was 15-to-20 feet of debris everywhere I went, and (not nearly enough) garbage trucks working 24/7 in a daunting task. Concerns were voiced regarding landfill space. Homeowners with insurance, I was told, could receive a maximum of $350,000 to cover the structure and property. Most homeowners didn’t have flood insurance, and will rely on FEMA money—a maximum of $35,000 to be received in installments and which must be spent on repairing the house. But many worry about living again in a property that may have suffered mold. “How could I take my children back in there?” 30 million gallons of sewage spilled into the waterways. “You can’t get a car if your life depended on it” in Houston; and although rental rates were slipping here because of overbuilding, today rental rates are “sky high.’’ It doesn’t help that, even before Harvey, nearly 70% of Texas contractors were having trouble finding concrete workers, electricians, cement masons and carpenters, according to a survey of construction firms that the Associated General Contractors of America conducted in July. Texas has long struggled to replenish its aging construction workforce. The average age of a master electrician in Texas is 59. For plumbers, it’s 62, according to a Sept. 13 Associated Press story. The state expected to see 30,000 single-family housing starts this year, and now an estimated 200,000 homes need to be repaired or rebuilt.

The current monetary environment remains decisively bullish, despite the Fed’s pledge to begin to unwind assets. The glacial pace of the run-off—which Fed Chair Yellen promised is a permanent feature—in no way represents policy tightening. All it does, Trend Macro says, is require a very risk-tolerant global market to absorb, very gradually, small amounts of duration, pre-payment and credit risk. Chances of a December rate hike have risen somewhat with the policymakers’ dismissal of the hurricanes’ effect, further abetted by Yellen’s comments this week that seemed to discourage the idea that a December hike will be the last one for a while. But is raising a negative real interest rate—currently -0.65% after adjusting for CPI—to something “a bit less negative” really tightening? It would take three more 25 basis-point hikes just to get the real target rate above zero. The takeaway—Trump and the other powers that be are doves, so regardless of what Yellen says, gradualism reigns, Rhino Trading Partners says. This is bullish. Houstonians are remarkable and many were joking about the hurricane. “They told us we were experiencing a 500-year flood in each of the last three years!” “People who say this was the worst flood ever forget the flood of 1900 which wiped Galveston off the map.” Most of my meetings this week started with 15 minutes of did-you-flood discussion before we got down to business and I was told several times that concerning the market, “nobody is euphoric out there.” Many residents are suffering from PTSD, spooked every time they hear thunder. But Houston is a resilient city and solid. From their own lips, “The sense of community is like nothing I’ve ever seen in my life.”

Positives

Capex on the rise Durable goods orders rebounded in August, with nondefense capital goods orders ex-aircraft—a key gauge of capital expenditures (capex)—rising for the sixth time in the past eight months as demand for capital equipment continues to pick up. In other positive signs for manufacturing, the Chicago PMI surged to a 29-year high, the Richmond Fed PMI matched a 7-year high and the Texas PMI rose to its highest level in 7 months as an improving outlook for the months ahead outweighed hurricane concerns.

Consumers remain upbeat The Conference Board’s Consumer Confidence Index edged down to 119.8 in September but continues to track close to its highest level since the spring of 2001. This month’s pullback reflected deterioration in the present situation component as expectations about the future improved. One sour note for automakers: plans to buy a vehicle over the next six months declined to a 1-year low (pre-Harvey.) Consumer sentiment also slipped on the month but remained near August’s 7-month high.

Trade may be additive In a plus for Q3 GDP, the nation’s trade gap in goods unexpectedly narrowed sharply in August on a jump in exports led by consumer and capital goods. Meanwhile, imports slipped. The report also includes preliminary data on August inventories at the wholesale and retail levels, both of which surged—also a positive for Q3 GDP.

Negatives

Where are we in the economic cycle? New home sales in August fell for a second month in a row, lowering annualized activity to a low for the year. Pending sales—a gauge of future existing home sales—also sank and has now declined in six of the past eight months, prompting the National Association of Realtors to now forecast sales for the year to fall below 2016 levels. Tight supply is an issue, but so are higher prices. The S&P CoreLogic National Home Price Index has risen 6% year-over-year, the biggest gain in three years.

Will the Fed pay much attention to this? Chair Yellen’s comments this week were somewhat dismissive of the recent spate of low inflation and were seen as strongly supporting the case for a December rate hike. But the price data continues to come in below expectations. Today’s report on August personal income and spending showed core PCE moderating to 1.3% and real PCE growth for the first two months of Q3 to track at 1.7% annualized. Wage and salary income for the month was flat while consumer spending was soft.

Sausage being made One of the biggest roadblocks to tax reform is the potential impact on the deficit. This is sure to get a lot of attention in coming weeks and won’t be helped by the latest estimates, which even before any tax-cut legislation, suggests the annual budget deficit relative to GDP is projected to grow from just 3% to more than 4.5% over the next 5 years. This would soon push total government debt above 100% of GDP. This is the biggest issue in the eyes of the House Freedom Caucus, which could gum up any budget-and-tax deal.

What else

Post-Equifax, maybe it’s time to ditch the Social Security number Critics say the simple 9-digit number comprised of three numerical groups (an area number, a group number, and a serial number) represents a predictable internal structure that takes much of the guess work out for hackers. In fact, back in 2009, researchers at Carnegie Mellon created an algorithm disturbingly proficient at guessing the SSN of individuals, using only the government’s Death Master File and publicly available information on social media. The SSN was designed for the needs of the Social Security Administration back in 1936. It was never intended for use as a universal personal identifier, certainly not in an age of high-speed computers and abundantly available personal information on social media.

For those worried the current expansion is getting old At 99 months, it is the third longest since 1945 and will soon become the second longest. However, length is not the defining characteristic of an economic cycle or most stock market peaks, Dudack Research notes. The most common trigger for a recession is an inverted yield curve, which is not a concern at this juncture. Dudack believes it would take two to four new target fund hikes simply to flatten the yield curve. Moreover, in the past, a recession has started 16 months after the Conference Board’s leading indicator index peaks. It rose a solid 0.4% in August and shows no sign of falling back anytime soon.

Cajun Navy to the rescue Houstonians reported that looting was kept to a minimum after the disaster, and that boat owners were expected to “go out and rescue.” Even a band of “Rednecks from Louisiana” came to help with their airboats, affectionately known as the Cajun Army.

Recent Equity

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

The Chicago Purchasing Managers Index, produced by the Institute of Supply Management-Chicago, gauges factory and services health in the upper Midwest based on surveys of companies in that region.

The Conference Board's Consumer Confidence Index measures how optimistic or pessimistic consumers are about the economy.

The CoreLogic Home Price Index measures year-over-year changes in home prices.

Consumer Price Index (CPI): A measure of inflation at the retail level.

The Federal Reserve Bank of Dallas' monthly Texas Manufacturing Outlook Survey is a measure of the current level of activity and expectations for the future.

The Federal Reserve Bank of Richmond surveys manufacturing and services businesses monthly to gauge their level of activity and expectations for the future.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

The Personal Consumption Expenditure Index: A measure of consumer inflation at the retail level that takes into account changes in consumption patterns due to price changes.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

The Conference Board's Composite Index of Leading Economic Indicators is used to predict the direction of the economy's movements in the months to come.

Yield Curve: Graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities.

The University of Michigan Consumer Sentiment Index is a measure of consumer confidence based on a monthly telephone survey by the University of Michigan that gathers information on consumer expectations regarding the overall economy.